Q.E. for Greece and the Eurozone

My Q: can you see any reason the ECB can’t do a version of QE for Greece? Not necessarily the US/UK way of buying bank bonds and hoping; there may be other ways? But if they could do it somehow, interest-free, so that the new money gets out into the economy, with the proviso that the money will slowly be paid back, but only after Greece finally reaches some positive economic level? Wouldn’t that be more palatable for Greece than having to *borrow* from the ECB at impossible rates? (It seems that the liquidity trap  will avoid any runaway inflation.)

Countries like Greece, Italy and Spain desperately need some form of monetary easing. Increasing the money supply (through some form of quantitative easing) should help to alleviate some of the problems associated with deflation and falling nominal GDP. (Greece recorded an inflation rate of -0.4% in June 2013) Amongst other things, they need an increase in the money supply to try and target higher nominal GDP. At the moment, several Euro countries are caught in a deflationary trap with falling GDP and simultaneously seeing an increase in their debt to GDP burden.

If a country like Greece was not in the Euro, but had their own currency – then the Greek Central Bank could decide to create money and purchase bonds. They could buy government bonds or corporate bonds; the important thing is that it would increase the money supply, reduce bond yields  and help to reduce deflationary pressures and stem the fall in nominal GDP. (It would also cause a large depreciation in the Greek currency, which is something they needed to restore competitiveness)

However, Greece does not have its own currency, it is in the Euro. Therefore, it is up to the European Central Bank. Many of the reasons to prevent Q.E. have been political and related to the set up of the Euro.

(I should point out my knowledge of ECB rules on Q.E. and printing money is somewhat shaky – partly because it is undergoing a process of constant change, and different people in the EU/ ECB have different views)

Firstly, the ECB used to have something in its charter prohibiting the creation of money. To some extent, Draghi’s put has circumscribed this. The ECB can now buy bonds with a 3 year or less maturity.

However, any extension of this decision to pursue a policy of quantitative easing needs to be approved by European Central Bank body. It relies on political support. Others in the EU may veto a plan for quantitative easing over deeply held fears of:

  1. Increasing money supply causing inflation.
  2. Rewarding fiscal profligacy through printing money and inflating away debts. There is a fear of moral hazard, and that it would encourage other countries to allow debts to rise.

In the case of Greece, Quantitative easing would not be a panacea. Greece is well beyond the situation of having liquidity shortages, it is fundamentally broke. However, quantitative easing to keep bond yields low, would give countries like Italy and Spain more time to deal with fiscal deficits – rather than the deeply counter-productive austerity measures we’ve seen in recent years.

Wouldn’t that be more palatable for Greece than having to *borrow* from the ECB at impossible rates?

It is a big problem that countries like Italy are running primary budget surpluses (but because of relatively high interest rates, it is insufficient to reduce debt to GDP ratios. It is estimated Italy will have to run a primary budget surplus of 5% of GDP to reduce long-term debt burden. But, this size of a primary deficit is highly contractionary. Quantitative easing to reduce bond yields would reduce the necessity of deep austerity measures.

It is a problem when countries with high debt, spend a high % of income just on debt interest payments.

Also, note a big problem Europe faces is that business face very high bank rates (bank rates are well above ECB base rates, e.g 6% in Spain). Q.E. could play a role in reducing this bank rates that are crippling European business. (see: Credit policy and gap of bank rates over base rates)

(It seems that the liquidity trap  will avoid any runaway inflation.)

Yes. a big mistake of the ECB over the past five years is to be worrying about inflation, when several countries are looking at the much more damaging reality of deflation. Spain, Italy, Greece and Portugal all are experiencing deflationary pressures as they try to become more competitive and reduced domestic demand. But, the cost to the economy is very high in terms of lost output and higher unemployment. There is a strong case for the ECB to be targeting higher inflation to ease the burden of adjustment. The prospect of runaway inflation in Europe is just not a reality. (See: How successful have Central banks been in managing the economy?)

Final note

It is a great shame that quantitative easing wasn’t pursued at the start of the crisis. The reluctance to help bond markets until mid way through 2012 meant Eurzone countries experienced artificially high bond yields and faced pressure to cut budget deficits much quicker and deeper than was desirable. This has created a deflationary dynamic which is going to be very hard to reverse.

Also, given deep structural problems of Europe, quantitative easing is no panacea. I don’t really know how much (different forms) of quantitative easing could help countries like Spain and Greece. But, it would, at least, be a start.

Also, it depends on the type of quantitative easing. There is a difference between increasing bank reserves, and actually increasing bank lending.
By, the way, people who say Quantiative easing has been a complete failure in the UK, should look at Europe. Those countries which haven’t been able to pursue quantitative easing have ended up with high debt, high bond yields and a deeper recession. Quantitative easing may have failed to create instant growth, but it did ease the UK situation regarding debt and bond yields.

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2 thoughts on “Q.E. for Greece and the Eurozone

  1. Another point is that when you’re in a monetary union with other countries, and you go along to the joint central bank and ask for some nice free freshly printed money, the other countries in the union will feel a bit sore if they don’t get their fair share of free money. But they (i.e. Germany) already have more or less full employment, so they don’t need oodles of freshly printed money. I.e. any such money creation of behalf of the periphery is effectively at the expense of the core / Germany.

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